A S-corp transfer rental property to the shareholders

[ylau110]

I and my husband are the shareholders of the s-corp.. The s-corp owns a rental property for 15 years. Now I want to transfer the property to our names and dissolve  the s-corp.  Should I transfer the property and close the corporation in the same month?  Is the transfer considered a distribution to shareholders at fair market value? How does the capital gain pass through to the shareholders? I really need help to plan for the tax consequence.

Yvonne

[Anonymous_]

@Rick19744 can post details (re liquidating and non-liquidating distributions), but you are essentially triggering a sale, under typical circumstances, when you distribute the property.

There are other considerations, and it is generally not recommended to transfer rental real estate to an S corporation.

[Mike9241]

Distributions of appreciated property are valued at fair market value. If property other than cash was distributed, attach a statement to provide the following information.
• The date the property was acquired.
• The date the property was distributed.
• The property's FMV on the date of distribution.
• The corporation's basis in the property.

Distributions
General rule. Unless the corporation
makes one of the elections described
below, property distributions (including
cash) are applied in the following order (to
reduce accounts of the S corporation that
are used to figure the tax effect of
distributions made by the corporation to its
shareholders).
1. Reduce the AAA determined
without regard to any net negative
adjustment for the tax year (but not below
zero). If distributions during the tax year
exceed the AAA at the close of the tax
year, determined without regard to any net
negative adjustment for the tax year, the
AAA is allocated pro rata to each
distribution made during the tax year. See
section 1368.
2. Reduce shareholders' PTEP
account for any section 1375(d) (as in
effect before 1983) distributions. A
distribution from the PTEP account is tax
free to the extent of a shareholder's basis
in his or her stock in the corporation.
3. Reduce AE&P. Generally, the S
corporation has AE&P only if it hasn't
distributed E&P accumulated in prior years
when the S corporation was a C
corporation (section 1361(a)(2)). See
section 312 for information on E&P. The
only adjustments that can be made to the
AE&P of an S corporation are:
a. Reductions for dividend
distributions;
b. Adjustments for redemptions,
liquidations, reorganizations, etc.; and
c. Reductions for investment credit
recapture tax for which the corporation is
liable.
See section 1371(c) and (d)(3).
4. Reduce the other adjustments
account (OAA).
5. Reduce any remaining
shareholders' equity accounts.
Elections relating to source of distributions.
The corporation may modify the
above ordering rules by making one or
more of the following elections.
Election to distribute AE&P first. If
the corporation has AE&P and wants to
distribute from this account before making
distributions from the AAA, it may elect to
do so with the consent of all its affected
shareholders (section 1368(e)(3)(B)). This
election is irrevocable and applies only for
the tax year for which it is made. For
details on making the election, see

Statement regarding elections. To make any of the above elections, the corporation must attach a statement to a timely filed original or amended Form 1120-S for the tax year for which the election is made. In the statement, the corporation must identify the election it is making and must state that each shareholder consents to the election. The statement of election to make a deemed dividend must include the amount of the deemed dividend distributed to each shareholder. For more details on the election, see Regulations section 1.1368-1(f)(5).

all this info can be found in 1120-S instructions

https://www.irs.gov/pub/irs-pdf/i1120s.pdf

from what I've seen some taxpayers handle real estate loss pass-throughs incorrectly when an S-Corp owns the property.  Mortgages do not provide tax basis to take losses.  so i've seen where shareholders take losses in excess of their tax basis. if this is your situation consult a tax pro.

[Rick19744]

You need to meet with a tax professional and have a one on one discussion of your goals and why you want to change the current structure.

I also agree that owing real estate in a corporation (or S corporation) is generally not a good move.

Transferring out the real estate to you and your husband (shareholders), will be treated as if you sold the property for FMV and you will trigger current tax.

This sale will be at the S corporation level and reported on your respective K-1 and then reported on your individual 1040.  This is triggering tax implications in which you have no cash to pay the tax.

Don't do anything until you have discussed the implications with a tax professional and you understand the implications.

[ylau110]

You mentioned that the sale will be at corporation level and reported on K1, is it a distribution I have to report on 1040 as ordinary income? This will increase my Stock and Debt basis, right? Upon liquidating the s-corp, since the stock has no value, then  I report loss on the stock on Schedule D on 1040. Do I on the right track?

[Mike9241]

the following assumes the corp has always been an S-Corp. the deemed sale would be treated as an actual sale with the result of depreciation recapture and capital gain.  these items are reported on the k-1 along with the distribution. the income items will increase your tax basis so in theory, the distribution should be equal to your tax basis. thus there is no additional gain nor is there any loss on the stock to be reported. You would still have to report the liquidation of the stock on your 1040. the sales price to be reported would be the distribution amount which should, in theory, equals your tax basis so there is no gain or loss.  however, it is best to use a tax pro to go over this transaction so there are no surprises.  

[Rick19744 · Accepted solution]

@ylau110 this is treated as an actual sale and then a liquidating distribution; two separate components.

The liquidating distribution of the property to the shareholders is treated as if it was an actual sale and the gain reported at the S corporation level and reported on the K-1.

It will also be treated as a liquidating distribution and reported on form 1099-DIV (not the K-1).

Based on your additional information of "zero"basis, you would arrive at the following:

• Beginning stock basis of zero
• Gain on the sale of the building $75,000; hypothetical amount.
  • Reported on the K-1 and then reported on your individual return
  • You will also have unrecaptured Section 1250 due to depreciation taken.  This will cap the gain on the building at 25%
• Your basis will increase by the $75,000 gain
• When reporting your final gain or loss on the S corporation liquidation, your "sales price" will be the FMV of property / building distributed; which we don't have the details on this figure.  Your cost basis will be the $75,000.  The FMV of the property will be reflected as a distribution on form 1099-DIV.
• So as you can see, this may not be a sum zero transaction
  • You will pay actual tax on the gain which will be capped at 25%; max $18,750 based on the hypothetical figure above
  • You may have tax on the liquidation of the S corporation stock; we don't have sufficient details to determine this.
  • So as noted previously, there may be actual tax consequences and real tax $$ out of pocket without any cash; since this is a deemed sale.
  • Have a tax professional run the numbers before you do anything.

[ylau110]

@Rick19744  Thanks for your contribution. It is a really complicated tax matter. Now I have more knowledge and I understand more when I talk to a tax pro.

[Rick19744]

You are welcome.  As you can see, this is not something where you want to be penny wise pound foolish.

@ylau110 I edited my previous response as the liquidating distribution of the property FMV will be reported on form 1099-DIV not the K-1; cash in box 9 and noncash in box 10.